New York futures moved lower this week, as December lost 131 points to close at 63.19 cents/lb, while March dropped 74 points to close at 62.28 cents/lb.

It was another uneventful week in the cotton market, as values continued to move within a very narrow trading range. Since October 6, the March contract, which as of today owns the highest open interest, has closed no lower than 61.71 cents and no higher than 63.27 cents, a range of just 156 points in 24 sessions! December, the soon to expire spot month, has seen a little more movement with a 306-point range, but even that is nothing to get too excited about.

The market still appears to be boxed in between strong resistance stemming from a global oversupply scenario that is likely to persist for quite a while, while support comes mainly from government programs in the US and India that keep supply pressures in check. Government support is changing the behavior of market participants, as it keeps potential short sellers from getting too aggressive, while allowing growers to hold on to their cotton longer than they otherwise would.

The US marketing loan program pays growers 52 cents/lb for their cotton, which corresponds to over 80% of its current market value. The grower then has 9-10 months to redeem his cotton at the AWP, which is determined by the A-index. In the current market environment a grower expects the AWP to move lower over the coming months, which would allow him to get his cotton back at a cheaper price.

Paradoxically, the more bearish producers are, the longer they may leave their cotton in the loan in anticipation of a falling AWP. This behavior in turn restricts the supply coming into the marketplace, which counterbalances bearish forces. The matter has been further complicated by lower payment limitations for growers this season, which makes it more difficult to trade cotton in equity form, for fear of owing the government some money back if marketing loan gains were to exceed payment limitations. In a nutshell, it may be more difficult to get cotton out of grower hands than in previous seasons.

A similar situation exists in India, where the CCI has started to procure cotton at the MSP (Minimum Support Price) in several states, which has kept cash prices fairly stable just shy of 70 cents. Even if the government ended up buying only 10% of the crop, which would equate to around 4 million local bales, it would probably be enough to keep Indian prices well supported. The psychological effect of these programs can be quite potent, because the perception of a safety net will keep growers from panicking, while mills are more confident to buy near the MSP and traders are reluctant to undercut prices.

Statistically the ROW should see its stocks grow by around 7 million bales this season and since both the US and Indian governments are not going to hold on to stocks indefinitely, this extra supply will sooner or later filter into the marketplace. The question is when and how much pressure will it generate?

US export sales were nothing to get excited about, as just 71’500 running bales found a home in 14 different markets, as higher prices kept many buyers away last week. Total commitments for the season now amount to 6.15 million statistical bales, of which just 1.2 million bales have so far been exported, which is the slowest pace since in 14 years.

The CFTC spec/hedge report confirmed that speculators were the sponsors behind last week’s rally, since they bought 1.05 million bales net, while the trade was selling 0.99 million bales net. Interestingly new spec buying (0.60 million bales) contributed a greater amount to the buying than spec short covering (0.45 million bales). Speculators are by no means a united front in the cotton market, since we currently have 6.4 million bales in outright longs opposing 7.0 million bales in outright shorts. These are fairly sizeable positions that could act as momentum boosters via short covering or long liquidation if the market were to break out of its current sideways pattern.

So where do we go from here? We feel that we are currently in a bear market with its hand brakes on, as various government support programs have proven effective in slowing down supply pressure. Nevertheless, there will be enough cotton in the ROW system this season to slowly but surely weigh prices down. It may just not happen as fast as many traders were expecting. With December going off the board, the market is finally going to transition from inversion to carry, which is more congruent with a bearish market environment. We expect carrying charges between March, May and July to build over the coming months.

Tomorrow’s option expiration and the beginning of the GSCI roll should make for a more lively market over the coming sessions. However, we don’t expect any fireworks in the final weeks of the December contract since there is enough cotton in the system to prevent a squeeze. Open interest should drop sharply once Dec goes off the board, since a large amount of it is tied to the Dec/March spread. We wouldn’t be surprised to see total open interest drop by 40-50k over the coming weeks, which will not be perceived as a bullish development.

Given the still sizeable outright spec short position we cannot rule any further spikes towards the mid 60s on short covering, but trade selling should be there to absorb the buying. Once December is off the board and harvest is completed we expect the A-index to drift towards 65-66 cents, which would open the door for NY futures to move to 58-59 cents.